The most (and least) exposed advanced markets to EM slowdown
China and other big emerging economies are slowing down; this will hit some developed markets more than others
The slowdown in emerging markets has continued in the second quarter of the year, with growth weakening again in April and with the emerging world advancing at its slowest pace since the global financial crisis, Capital Economics' gross domestic product tracker shows.
"The next year is likely to prove difficult for most emerging markets," where "a sustained recovery remains some way away," Gareth Leather, an economist for Asia at Capital Economics, said.
Leather added that the slowdown in the biggest emerging markets is "largely the result of structural factors" and that "these economies are likely to continue to disappoint."
The most vulnerable developed country to shocks coming from the slowdown in emerging economies is Australia, according to Alberto Gallo, head of European macro credit research at RBS.
"Australian exports and growth will suffer from slower growth from its emerging market trade partners as well as declining commodity prices," Gallo wrote in a note.
"The housing market appears overvalued and consumers are highly leveraged, and in our view a correction is long overdue."
He noted that China is the main export partner of Australia, making up almost a third of its exports. The Asia-Pacific region as a whole accounts for 80% of Australian exports.
"Growth across the region is slowing and will likely lead to lower exports in the future," Gallo noted.
Australia is likely to suffer also because "the decade-long commodities boom is coming to an end," he added. The country relies on mining for more than 50% of its exports and for about 20% of its overall economic growth.
The least vulnerable developed market to the slowdown in emerging markets is Europe, and more specifically the eurozone, according to Gallo.
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RBS strategists are overweight Europe as they believe there will be additional fiscal and monetary stimulus to end the recession and due to the agreement by the Council of the European Union on a common position to tackle bank crises.
"The next weeks of summer may be volatile, but these measures will bring credit risk down towards year-end, in our view," Gallo said.
He recommended going short iTraxx Australia versus long iTraxx Europe, targeting a 2% gain over six months and with a stop loss of -1%. Gallo believes that the fact that the European Central Bank will become Europe's bank regulator this year will "favour convergence across core-periphery bank spreads."
The RBS strategists are long eurozone periphery banks in senior debt but are short the subordinated debt of Italian and Spanish banks.
"Europe [credit] will outperform the US, and we forecast 4% and 9% total returns from European investment grade and high yield, respectively, in 2013," Gallo wrote.
"Within the European periphery, we prefer Ireland, Portugal and Greece to Spain and Italy."
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